Subjective Expectations and Uncertainty

Andrzej Kocięcki, Tomasz Łyziak and Ewa Stanisławska

No 2022-10, Working Papers from Faculty of Economic Sciences, University of Warsaw

Abstract: Analysis of macroeconomic expectations of private sector agents reveals not only the path of expected macroeconomic developments and the mechanism of expectation formation, but also the degree of uncertainty faced by economic agents. Relying on this observation the aim of this paper is twofold. First, we lay down the formal theory of subjective expectations and derive the subjective assessment hypothesis, which defines the optimal forecast of an individual under a specific loss function. Keeping the mathematical rigor, the proposed theory attempts to reflect the process of expectation formation that is consistent with well known behavioral features. Second, we apply the subjective assessment hypothesis to pin down the notion of uncertainty. We propose a novel uncertainty index, retrieved from forecast revisions of professional forecasters using an empirical model within the Bayesian approach. The two versions of this index derived for the US—based either on GDP growth or on inflation forecasts—describe different kinds of macroeconomic uncertainty. Their shocks act similarly as demand shocks, pushing economic activity and inflation down.

Keywords: Subjective expectations; Uncertainty; Stochastic volatility; Identification; Bayesian approach; Survey of Professional Forecasters (search for similar items in EconPapers)
JEL-codes: C10 C11 D81 D84 E31 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2022
New Economics Papers: this item is included in nep-upt
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https://www.wne.uw.edu.pl/download_file/1591/0 First version, 2022 (application/pdf)

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Working Paper: Subjective Expectations and Uncertainty (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:war:wpaper:2022-10

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